Financial Management
Touchtone Pty Ltd is considering investing in either of two competing projects that will allow the company to eliminate a production bottleneck and meet the growing demand for its products. The company's engineering department narrowed the alternatives down to two - Status Quo (SQ) and High Tech (HT). Working with the accounting and finance personnel, the company's CFO developed the following estimates of the cash flows for SQ and HT over the relevant 6-year time horizon. The firm has an 11 per cent required return and views these projects as equally risky.
| Year |
Project SQ |
Project HT |
| Cash Flows |
| 0 |
-$670,000 |
-$940,000 |
| 1 |
$250,000 |
$170,000 |
| 2 |
200,000 |
180,000 |
| 3 |
170,000 |
200,000 |
| 4 |
150,000 |
250,000 |
| 5 |
130,000 |
300,000 |
| 6 |
130,000 |
550,000 |
a. Calculate the Net Present Value (NPV) of each project, assess its acceptability, and indicate which project is best using NPV.
b. Calculate the Pay Back Period (PBP) of each project, assess its acceptability, and indicate which project is best using NPV
c. Calculate the Internal Rate of Return (IRR) of each project, assess its acceptability, and indicate which project is best using IRR.
d. Calculate the Profitability Index (PI) of each project, assess its acceptability, and indicate which project is best using PI.
e. Which of the two mutually exclusive projects would you recommend Touchtone Pty Ltd undertake? Why.